Options Trade of the Week

As a special service to my readers, I will be offering you one interesting trade idea every few weeks…for educational purposes only and to throw some light on my process and strategies when trading options.
I say for educational purposes only because there will not be a follow-up on the trade. And quite honestly, a follow-up would only occur if the trade went awry. But as we all know, losing trades happen, regardless of the strategy you use.
The key to keeping losses to a minimum is proper position-sizing. Most of the strategies I offer are risk-defined so you know at order entry how much is at risk. And knowing how much is at risk should give you a good idea what your position-size should be per trade.

Here’s Our First Options Trade of the Week 

Let’s examine a weekly options trade.
The overall market, more specifically the S&P 500 as seen through the ETF SPY, is in an overbought state,  according to my favorite mean-reversion indicator, RSI.

Once I see confirmation of an overbought state in one of the highly liquid ETFs I follow, I want to immediately look towards a trade.

Above is the weekly options chain for SPY.
With SPY trading for roughly $203.50 and in an overbought state, I want to use a strategy like a bear call spread. A bear call spread will enable me a margin of error just in case the current directional trend, in this case a bullish trend, continues.
The next step would be to choose the actual spread. I want to start by looking at the Prob.OTM column in search for a probability of success around 80%. If I were to choose the strike price closest to 80%,  I would need to sell the 205.5 strike. However, since I only want to go out one strike wide I would need to buy the 206.5 strike and that would only bring in a premium of $0.09. After commissions, $0.09 doesn’t allow for much of a gain.
So, the next step is to move further down the options chain towards the 205 strike.
I can sell the 205/204 bear call spread for $0.13 ($0.49-$0.36). By selling the next strike lower I am able to make a return of 14.9% over the next seven days. The quandary is that I only have a 72.1% chance of success compared to my typical 80%.
But again, given the extreme overbought nature of SPY I am comfortable pushing forward with the trade, especially knowing that 2 of the seven days are weekend days. So in reality I am only exposed to 5 trading days.
I’ve been trading weekly options in my Weekly Portfolio for my Options Advantage service since late February and so far I have had one losing trade. More importantly, the return on capital is over 60%. I do things a bit differently than most other weekly options services. I do not make a trade every week. I wait for overbought/oversold extremes to enter the market and then I begin to look for a trade. For one to randomly select based on the fact that it is a new week is irresponsible, in my opinion. The market doesn’t work that way. I mean what’s the hurry? We are in this for the long haul.
Several months ago I gave a webinar on Weekly Options and my approach. If you would like to learn more, click here.
And as always, if you have any questions please feel free to email me.

Special Options Advantage Offer

If you ever thought about delving deeper into the options market – and seeing my personal options trades and recommendations on a regular basis – I’ve got some great news. My premium trading service, The Options Advantage, is available now for 50% off the regular rate. Click here to subscribe.